Lending Activities
General: All of our lending activities are conducted through Banner Bank, its
subsidiary, Community Financial Corporation, a residential construction lender
located in Portland, Oregon, and Islanders Bank. We offer a wide range of loan
products to meet the demands of our customers and our loan portfolio is very
diversified by product type, borrower and geographic location within our market
area. We originate loans for our own loan portfolio and for sale in the secondary
market. Management’s strategy has been to maintain a well diversified
portfolio with a significant percentage of assets in the loan portfolio having
more frequent interest rate repricing terms or shorter maturities than traditional
long-term fixed-rate mortgage loans. As part of this effort, we offer a variety
of floating or adjustable interest rate products that correlate more closely
with our cost of interest bearing funds, particularly loans for commercial business
and real estate, agricultural business, and construction and development purposes.
However, in response to customer demand, we continue to originate fixed-rate
loans, including fixed interest rate mortgage loans with terms of up to 30 years.
The relative amount of fixed-rate loans and adjustable-rate loans that can be
originated at any time is largely determined by the demand for each in a competitive
environment.
Our lending activities are primarily directed toward the origination of real
estate and commercial loans. Commercial real estate loans include owner-occupied,
investment properties, multifamily residential real estate and construction
and development loans for these types of properties. Although our level of activity
and investment in commercial and multifamily real estate loans has been relatively
stable for many years, we have experienced an increase in new originations in
recent periods resulting in growth in these loan balances. In addition, the
AmericanWest and Siuslaw Bank acquisitions substantially increased the balances
of our commercial and multi-family real estate loans. We also originate residential
construction, land and land development loans and, although our portfolio balances
are well below the peak levels before the recent recession, since 2011 we have
experienced increased demand for one- to four-family construction loans. While
our origination of construction and development loans has been significant during
this period, balances in this portion of the portfolio have only increased modestly
in recent periods as brisk sales of new homes have produced rapid turnover through
repayments. Our commercial business lending is directed toward meeting the credit
and related deposit and treasury management needs of various small- to medium-sized
business and agribusiness borrowers operating in our primary market areas. In
recent years, our commercial business lending has also included participation
in certain national syndicated loans.
Our residential mortgage loan originations have been relatively strong in recent
years, as exceptionally low interest rates have supported demand for loans to
refinance existing debt as well as loans to finance home purchases. However,
most of the one- to four-family loans that we originate are sold in the secondary
markets with net gains on sales and loan servicing fees reflected in our revenues
from mortgage banking. As a result, excluding loans acquired through the acquisitions,
growth in this portion of our portfolio has been modest.
Construction and Land Lending: Historically, we have invested a significant
portion of our loan portfolio in residential construction and land loans to
professional home builders and developers. We also make construction loans to
qualified owner occupants, which upon completion of the construction phase convert
to long-term amortizing one-to-four family residential loans that are eligible
for sale in the secondary market. We regularly monitor our construction and
land loan portfolios and the economic conditions and housing inventory in each
of our markets and increase or decrease this type of lending as we observe market
conditions change. Beginning in 2011, in response to improvement in certain
sub-markets, our residential construction and land and land development lending
has been increasing and has made a meaningful contribution to our net interest
income and profitability. To a lesser extent, we also originate construction
loans for commercial and multifamily real estate. Although well diversified
with respect to sub-markets, price ranges and borrowers, our construction, land
and land development loans are significantly concentrated in the greater Puget
Sound region of Washington State and the Portland, Oregon market area. At December
31, 2015, construction, land and land development loans totaled $574.4 million,
or 8% of total loans; the balance was primarily comprised of one- to four-family
construction and residential land or land development loans, and to a lesser
extent commercial and multifamily real estate construction loans and commercial
land or land development loans.
Construction and land lending affords us the opportunity to achieve higher
interest rates and fees with shorter terms to maturity than are usually available
on other types of lending. Construction and land lending, however, involves
a higher degree of risk than other lending opportunities because of the inherent
difficulty in estimating both a property’s value at completion of the
project and the estimated cost of the project. If the estimate of construction
cost proves to be inaccurate, we may be required to advance funds beyond the
amount originally committed to permit completion of the project. If the estimate
of value upon completion proves to be inaccurate, we may be confronted at, or
prior to, the maturity of the loan with a project the value of which is insufficient
to assure full repayment. Disagreements between borrowers and builders and the
failure of builders to pay subcontractors may also jeopardize projects. Loans
to builders to construct homes for which no purchaser has been identified carry
additional risk because the payoff for the loan is dependent on the builder’s
ability to sell the property before the construction loan is due. We attempt
to address these risks by adhering to strict underwriting policies, disbursement
procedures and monitoring practices.
Construction loans made by us include those with a sales contract or permanent
loan in place for the finished homes and those for which purchasers for the
finished homes may be identified either during or following the construction
period. We actively monitor the number of unsold homes in our construction loan
portfolio and local housing markets to attempt to maintain an appropriate balance
between home sales and new loan originations. The maximum number of speculative
loans (loans that are not pre-sold) approved for each builder is based on a
combination of factors, including the financial capacity of the builder, the
market demand for the finished product and the ratio of sold to unsold inventory
the builder maintains. We have attempted to diversify the risk associated with
speculative construction lending by doing business with a large number of small
and mid-sized builders spread over a relatively large geographic region with
numerous sub-markets within our service area.
Loans for the construction of one- to four-family residences are generally
made for a term of twelve to eighteen months. Our loan policies include maximum
loan-to-value ratios of up to 80% for speculative loans. Individual speculative
loan requests are supported by an independent appraisal of the property, a set
of plans, a cost breakdown and a completed specifications form. Underwriting
is focused on the borrowers’ financial strength, credit history and demonstrated
ability to produce a quality product and effectively market and manage their
operations. All speculative construction loans must be approved by senior loan
officers.
Commercial and Multifamily Real Estate Lending: We originate loans secured
by multifamily and commercial real estate including, as noted above, loans for
construction of multifamily and commercial real estate projects. Commercial
real estate loans are made for both owner-occupied and investor properties.
Because payments on loans secured by multifamily and commercial properties are
often dependent on the successful operation and management of the properties,
repayment of these loans may be affected by adverse conditions in the real estate
market or the economy. In addition, many of our commercial and multifamily real
estate loans often are not fully amortizing and contain large balloon payments
upon maturity. Such balloon payments may require the borrower to either sell
or refinance the underlying property in order to make the payment, which may
increase the risk of default or non-payment. In originating multifamily and
commercial real estate loans, we consider the location, marketability and overall
attractiveness of the properties. Our underwriting guidelines for multifamily
and commercial real estate loans require an appraisal from a qualified independent
appraiser and an economic analysis of each property with regard to the annual
revenue and expenses, debt service coverage and fair value to determine the
maximum loan amount. In the approval process we assess the borrowers’
willingness and ability to manage the property and repay the loan and the adequacy
of the collateral in relation to the loan amount.
Commercial business loans may entail greater risk than other types of loans.
Commercial business loans may be unsecured or secured by special purpose or
rapidly depreciating assets, such as equipment, inventory and receivables, which
may not provide an adequate source of repayment on defaulted loans. In addition,
commercial business loans are dependent on the borrower’s continuing financial
strength and management ability, as well as market conditions for various products,
services and commodities. For these reasons, commercial business loans generally
provide higher yields or related revenue opportunities than many other types
of loans but also require more administrative and management attention. Loan
terms, including the fixed or adjustable interest rate, the loan maturity and
the collateral considerations, vary significantly and are negotiated on an individual
loan basis.
Agricultural operating loans generally are made as a percentage of the borrower’s
anticipated income to support budgeted operating expenses. These loans are secured
by a blanket lien on all crops, livestock, equipment, accounts and products
and proceeds thereof. In the case of crops, consideration is given to projected
yields and prices from each commodity. The interest rate is normally floating
based on the prime rate or a LIBOR index plus a negotiated margin. Because these
loans are made to finance a farm or ranch’s annual operations, they are
usually written on a one-year review and renewable basis. The renewal is dependent
upon the prior year’s performance and the forthcoming year’s projections
as well as the overall financial strength of the borrower. We carefully monitor
these loans and related variance reports on income and expenses compared to
budget estimates. To meet the seasonal operating needs of a farm, borrowers
may qualify for single payment notes, revolving lines of credit and/or non-revolving
lines of credit.
Consumer and Other Lending: We originate a variety of consumer loans, including
home equity lines of credit, automobile, boat and recreational vehicle loans
and loans secured by deposit accounts. While consumer lending has traditionally
been a small part of our business, with loans made primarily to accommodate
our existing customer base, it has received consistent emphasis in recent years.
Part of this emphasis includes a Banner Bank-owned credit card program. Similar
to other consumer loan programs, we focus this credit card program on our existing
customer base to add to the depth of our customer relationships. In addition
to earning balances, credit card accounts produce non-interest revenues through
interchange fees and other activity-based revenues. Our underwriting of consumer
loans is focused on the borrower’s credit history and ability to repay
the debt as evidenced by documented sources of income.
Investment Securities
Under Washington state law, banks are permitted to invest in various types
of marketable securities. Authorized securities include but are not limited
to Treasury obligations, securities of various federal agencies (including government-sponsored
enterprises), mortgage-backed and asset-backed securities, certain certificates
of deposit of insured banks and savings institutions, bankers’ acceptances,
repurchase agreements, federal funds, commercial paper, corporate debt and equity
securities and obligations of states and their political subdivisions. Our investment
policies are designed to provide and maintain adequate liquidity and to generate
favorable rates of return without incurring undue interest rate or credit risk.
Our policies generally limit investments to U.S. Government and agency (including
government-sponsored entities) securities, municipal bonds, certificates of
deposit, corporate debt obligations and mortgage-backed securities. Investment
in mortgage-backed securities may include those issued or guaranteed by Freddie
Mac, Fannie Mae, Government National Mortgage Association (Ginnie Mae or GNMA)
and investment grade privately-issued mortgage-backed securities, as well as
collateralized mortgage obligations (CMOs). All of our investment securities,
including those that have high credit ratings, are subject to market risk in
so far as a change in market rates of interest or other conditions may cause
a change in an investment’s earnings performance and/or market value.
Derivatives
The Company, through its Banner Bank subsidiary, is party to various derivative
instruments that are used for asset and liability management and customer financing
needs. Derivative instruments are contracts between two or more parties that
have a notional amount and an underlying variable, require no net investment
and allow for the net settlement of positions. The notional amount serves as
the basis for the payment provision of the contract and takes the form of units,
such as shares or dollars. The underlying variable represents a specified interest
rate, index, or other component. The interaction between the notional amount
and the underlying variable determines the number of units to be exchanged between
the parties and influences the market value of the derivative contract. We obtain
dealer quotations to value our derivative contracts.
Our predominant derivative and hedging activities involve interest rate swaps
related to certain term loans and forward sales contracts associated with mortgage
banking activities. Generally, these instruments help us manage exposure to
market risk and meet customer financing needs. Market risk represents the possibility
that economic value or net interest income will be adversely affected by fluctuations
in external factors such as market-driven interest rates and prices or other
economic factors.
Derivatives Designated in Hedge Relationships